FINA Committee Report

As discussed in Chapters Two, Three and Four, there are a variety of measures that might be taken by the federal government to enhance the competitiveness of Canada’s people, communities and businesses. Most of these measures involve a federal cost, whether in the form of program expenditures or forgone tax revenues. Consequently, it is important to ensure that the fiscal position of the government, both now and in the future, is such that the government has the resources to invest in our people, our communities and our businesses in order to ensure the competitiveness of our nation.

This fiscal goal could be achieved through a commitment to prudent fiscal planning, sustainable growth in federal budgetary program and tax expenditures, balanced federal budgets, repayment of the accumulated federal deficit, and periodic review of the effectiveness and desirability of federal programs. While federal finances are currently relatively sound, the financing of measures designed to enhance our competitiveness through investments in our people, our communities and our businesses may require that choices be made, particularly if the cost of existing programs and services continues to grow, if federal revenues are reduced, or if other unforeseen events that affect federal revenues and expenditures occur.

ECONOMIC CONTEXT

During his 19 October 2006 appearance before the House of Commons Standing Committee on Finance, the Governor of the Bank of Canada indicated that the Canadian economy is thought to be operating just above its production capacity. The Bank estimates that the Canadian economy will grow by 2.8% in 2006 and by 2.5% in 2007, following a 3.3% and 2.9% increase in real Gross Domestic Product (GDP) in 2004 and 2005 respectively, as shown in Figure 17. These estimates are lower than those presented in the Bank’s July 2006 Monetary Policy Report and mostly reflect a weaker near-term U.S. economic outlook that could negatively affect the level of Canadian exports.

The Bank of Canada’s economic growth estimates are similar to those presented by the Minister of Finance in The Economic and Fiscal Update on 23 November 2006. According to The Economic and Fiscal Update, real Canadian GDP is expected to grow by 2.75% in both 2006 and 2007.

Economic projections are subject to both downside and upside risks. According to the Governor of the Bank of Canada, the main downside risk to the Bank’s projections is that U.S. economic growth could be lower than expected, leading to lower Canadian exports. The main upside risk to the projections is stronger-than-anticipated household spending in Canada, in the event that housing prices are higher than expected or the link between consumer credit and housing prices is stronger than currently assumed by the Bank.

The Minister of Finance identified the risks to the Canadian economic outlook presented on 23 November 2006 as largely external. In his view, the risks are related to the U.S. housing market, select commodity prices and global current account imbalances.

As well, the Minister indicated that domestic demand growth has been solid, employment growth is at a record high, the unemployment rate is close to its 31-year low, and income growth has been sound. From a business perspective, business non-residential investment growth has remained solid, corporate profit growth has been strong, world demand has continued to increase, and export prices have improved.

Figure 17: Real Gross Domestic Product Growth, Canada, 2004 to 2007

f: Forecast from the October 2006 Monetary Policy Report.
Source: Statistics Canada Table 380-0017 and Bank of Canada, Monetary Policy Report, October 2006.

While the economic projections suggest continued economic stability, the Canadian economy may face relatively significant challenges in the future. For example, more intense competition from lower-cost, knowledge-intensive countries such as China, continued globalization, and demographic change resulting in skill shortages create challenges for Canadian businesses and for Canadians. Negative effects may be experienced by some lower-skilled Canadians and by Canadian businesses unable to adapt to new competitive realities.

Furthermore, many Canadian businesses — as well as individual Canadian consumers — may continue to feel the effects of the recent increases in the price of crude oil and in the relative value of the Canadian dollar, as shown in Figure 18. The rise in the relative value of the Canadian dollar has had negative implications for some Canadian businesses that export their goods and services, particularly those in the manufacturing sector. The appreciation in the relative value of the Canadian dollar has also, however, resulted in less expensive foreign goods and services for Canadian consumers. High oil prices, while beneficial for oil-producing provinces, have exacerbated the financial difficulties experienced by some Canadian businesses, affected consumer spending, and led to speculation about inflation.

The Governor of the Bank of Canada has indicated that Canadian workers and businesses have shown impressive resilience in recent years; this resilience is a reflection of the flexibility of the Canadian economy. Enhanced flexibility — as evidenced, for example, by the movement of workers from region to region — should allow the Canadian economy to respond better to economic shocks and should enable the nation to remain competitive in a changing economic environment.

Figure 18: Daily Price of Crude Oil and the Relative

Value of the Canadian Dollar, January 2004 to October 2006

Source: Bank of Canada and the U.S. Department of Energy.

FISCAL OUTLOOK

From an historical and an international perspective, federal finances are — at present — sound, and current estimates project continued federal balanced budgets or better for the foreseeable future. In 2005-2006, the federal government reported a budgetary surplus of $13.2 billion, as shown in Figure 19. According to the Organisation for Economic Co-operation and Development, Canada was the only Group of Seven country to record a surplus in 2005.

The Economic and Fiscal Update presented by the Minister of Finance on 23 November 2006 projects federal budget planning surpluses of $4.2 billion and $3.5 billion in 2006-2007 and 2007-2008 respectively, after considering annual planned debt reduction of $3 billion. The planning surplus for the subsequent four years is expected to be $2.4 billion for 2008-2009, $2.0 billion for 2009-2010, $3.6 billion for 2010-2011 and $2.9 billion for 2011-2012, again considering $3 billion in annual planned debt reduction.

In The Economic and Fiscal Update, the Minister of Finance announced a federal commitment to reduce the federal debt-to-GDP ratio to 25% by 2012-2013, one year earlier than indicated in The Budget Plan 2006. The Minister also said that unanticipated federal budgetary surpluses would be used to accelerate federal debt repayment, and that the country should aim to eliminate total government net debt in less than a generation.

Fiscal projections are also subject to risks. According to the Minister of Finance, the current risks are associated with the economic outlook, federal departmental spending, and changes in the relationship between economic growth and tax revenues.

Figure 19: Fiscal Outlook, Federal Government, Canada, 2004-2005 to 2007-2008 (billions of dollars)

p: Projections contained in The Economic and Fiscal Update, 23 November 2006.
Source: The Economic and Fiscal Update, 23 November 2006 and the 2005-2006 Annual Financial Report of the Government of Canada.

FEDERAL SPENDING AND THE BUDGET-MAKING PROCESS

A.        WHAT WE HEARD

A number of witnesses commented that federal spending has increased significantly in recent years. For example, the Canadian Institute of Chartered Accountants informed the Committee that if program spending had grown at the rate of inflation and population growth between 1999-2000 and 2004-2005, total federal spending in 2004-2005 would have been $36 billion lower. In the view of some witnesses, high rates of growth in federal spending could compromise the federal government’s ability to reduce personal and corporate taxes and to address the challenges associated with demographic change. When expressed as a percentage of Gross Domestic Product, however, federal program expenses are not particularly high from an historical perspective, although there has been an upward trend since 2000-2001, as shown in Figure 20.

Figure 20: Federal Budgetary Revenues and Program Expenses

as a Percent of Gross Domestic Product, Canada, 1983-1984 to 2005-2006

Source: Department of Finance Canada and Statistics Canada Table 380-0017.

Given the rate of growth in federal spending, witnesses proposed limits on spending growth. The St. John’s Board of Trade proposed to limit federal program spending growth to about 3% per year, while the Canadian Institute of Chartered Accountants advocated the establishment of a framework whereby overall spending would not exceed the rate of inflation after adjustments for population growth. Other witnesses, including the Business Tax Reform Coalition, the Canadian Chemical Producers’ Association and the Winnipeg Chamber of Commerce, supported the idea of limiting the rate of federal spending growth to that of the economy, as measured by the rate of growth in the Gross Domestic Product. Witnesses told the Committee that when program spending growth exceeds economic growth, Canada’s competitiveness is reduced.

Other witnesses, however, argued that additional federal spending could enhance Canada’s competitiveness. The Canadian Centre for Policy Alternatives suggested that additional investment in skills and education, affordable housing, and adequate public transportation and infrastructure would have had a relatively more beneficial effect on competitiveness than the recent tax reductions. The Canadian Labour Congress informed the Committee that recent international experience demonstrates that high levels of public investment as well as high labour and social standards result in superior economic and social development outcomes when compared to low taxes, minimal levels of social investment and weak regulation of business.

Some witnesses advocated a more inclusive budget-making process. The Canadian Union of Public Employees said that Canada has one of the most secretive budget processes in the western world. KAIROS: Canadian Ecumenical Justice Initiatives proposed the establishment of a commission to study the means by which opportunities for public deliberation and the determination of consensus opinions on values and priorities in the budget-making process might be increased. Witnesses also acknowledged the contribution made by the Committee’s pre-budget consultations to the transparent and inclusive nature of the federal budget-making process.

A number of witnesses, including the Canadian Labour Congress and the Canadian Union of Public Employees, identified the need for greater consultation prior to reductions in federal program funding as a consequence of the federal government’s reallocation of resources. Witnesses suggested that Canadians be given an opportunity to appear before the appropriate parliamentary committees before program reductions occur. The Canadian Institute of Chartered Accountants recommended that program spending be monitored through a system of outcomes-based performance measures reflecting best practices and benchmarks from other countries. Improved timeliness of reporting of the federal government’s financial statements was also urged.

B.        WHAT WE BELIEVE

The Committee supports federal program spending in areas that have been identified as priorities by Canadians. That being said, we do not support federal spending that would result in federal budgetary deficits. As noted below, Canadians have made sacrifices in order that the nation’s budget could be balanced, and we do not want to return to budgetary deficits.

Because the federal budget sets out the taxation and program spending measures that affect all Canadians, the Committee believes that the federal budget-making process must be inclusive. Thus, we are of the view that, as the budget is being developed, formal consideration must be given to determining the impact of the proposed measures on various groups in our society and on various regions in our country. We also believe that since federal revenues are provided by taxpayers, some mechanism should exist whereby they are consulted before significant funding reallocation decisions are implemented.

The Committee believes in the importance of long-term planning. In our view, growth in federal program spending must be reasonable and must reflect the priorities of Canadians. We support a program expenditure review exercise that would aid in the identification of areas where funds could be reduced in order to be reallocated to other, higher-priority areas identified by Canadians. From this perspective, and bearing in mind the comments made to us by the Minister of Finance on 23 November 2006 about a forthcoming announcement by the President of the Treasury Board regarding an expenditure management system, growth in federal program expenditures below the rate of economic growth over the medium term and the need for program spending growth to exceed economic growth in some years, the Committee recommends that:

RECOMMENDATION 40

The federal government ensure that annual rates of increase in federal program spending not exceed the rate of growth in the nominal Gross Domestic Product, except in extraordinary circumstances.

The government should also institute a permanent mechanism by which federal taxation and program expenditures are reviewed annually. This mechanism should require consultations with Canadians about their priorities in the context of such considerations as public interest, the appropriate role of the federal government, federalism, fiscal balance, partnerships, value for money, efficiency and affordability.

Finally, the government should develop a mechanism by which Canadians are consulted prior to implementing decisions resulting from the review of federal taxation and program expenditures.

BALANCED FEDERAL BUDGETS AND THE USE OF BUDGETARY SURPLUSES

A.        WHAT WE HEARD

A number of witnesses, including the Canadian Chemical Producers’ Association, Canadian Manufacturers & Exporters and the Vancouver Board of Trade, told the Committee that the federal government should continue to pursue balanced budgets and to demonstrate fiscal prudence. Since 1997-1998, there has been a federal budgetary surplus each year. As shown in Figure 21, these surpluses have allowed the federal debt-to-GDP ratio to be reduced to 35.1% in 2005-2006, a reduction from its peak of 68.4% in 1995-1996.

Witnesses shared their views about how best to use any future federal budgetary surplus. Some witnesses, including the Saskatchewan Chamber of Commerce, told the Committee that interest charges on the federal debt limit the ability to invest in new programs or to provide further tax reductions. In 2005-2006, federal public debt charges totalled $33.8 billion or 16.2% of total federal expenditures. It was argued that lower public debt charges, in future, would allow the nation to finance better the budgetary priorities of Canadians.

Figure 21: Federal Debt-to-Gross Domestic Product Ratio,

Canada, 1983-1984 to 2005-2006

Source: Department of Finance Canada and Statistics Canada Table 380-0017.

Consequently, a number of witnesses indicated that the federal government should allocate at least a portion of any federal budgetary surplus to debt repayment. While some witnesses, including the Canadian Vintners Association, the Credit Union Central of Canada and the Ontario Chamber of Commerce, said that they support the objective contained in The Budget Plan 2006 to reduce the federal debt-to-GDP ratio to 25% by 2013-2014, others argued that the federal government should do more to reduce the size of the public debt.

The British Columbia Chamber of Commerce and the Greater Kitchener Waterloo Chamber of Commerce recommended that the federal debt-to-GDP ratio be reduced to below 25% by 2012, while the Canadian Institute of Chartered Accountants proposed that the federal government increase the amount of the planned annual debt repayment to $5 billion and that it reduce the debt-to-GDP ratio to 20% no later than 2013-2014; the Vancouver Board of Trade advocated a debt-to-GDP target of 20% by 2020. The Ontario Chamber of Commerce and the St. John’s Board of Trade told the Committee that any unplanned federal budgetary surplus should be allocated to debt repayment.

Not all witnesses, however, supported the allocation of federal budgetary surpluses to debt repayment. For example, the Confédération des syndicats nationaux told the Committee that balanced budgets, coupled with sustained GDP growth, should be adequate to reduce the federal debt-to-GDP ratio, particularly in a context where many public services and social programs are under-funded and some sectors of the economy need special attention. The Consortium of Women’s Organizations of Nova Scotia argued that debt repayment and tax reductions for high-income earners must not come at the expense of social programs that address, among other objectives, the high rate of poverty.

The Canadian Teachers’ Federation suggested that investment in the health and well-being of Canada’s children and youth will result in greater long-run benefits than will debt repayment and tax reductions. The Canadian Labour Congress suggested that increased government expenditure is a preferred alternative to debt repayment.   

B.        WHAT WE BELIEVE

The Committee believes that the federal government must, at a minimum, pursue balanced federal budgets. We recognize the sacrifices that were made by Canadians to end the cycle of budgetary deficits, and feel that the nation must not return to that pattern. Moreover, we support the practice of allocating a specified amount for planned debt reduction. Mindful of the desire by many Canadians to avoid federal budgetary deficits, and bearing in mind the 23 November 2006 comments to us by the Minister of Finance about planned annual debt reduction and balanced federal budgets, the Committee recommends that:

RECOMMENDATION 41

The federal government continue to pursue a balanced budget in order to avoid federal budgetary deficits.

As well, the government should continue to include, in its budget planning, an annual allocation of $3 billion for repayment of the accumulated federal deficit.

The Committee feels that at least some portion of any federal budgetary surplus must continue to be applied to the accumulated federal deficit in order to achieve several goals: to lower our debt servicing costs, to reduce the burden on future generations, and to remain the envy of the Group of Seven countries because of our fiscal performance.

While the Committee recognizes that some Canadians believe that federal budgetary surpluses should be allocated to purposes other than continued debt reduction, we believe that an ongoing effort to reduce the accumulated federal deficit is the correct approach. From this perspective, and bearing in mind the comments made to us by the Minister of Finance on 23 November 2006 about the allocation of unanticipated budget surpluses to debt repayment and the federal debt-to-GDP ratio, the Committee recommends that:

RECOMMENDATION 42

The federal government continue to allocate a portion of any federal budgetary surplus to a reduction in the accumulated federal deficit.

Moreover, the government should continue to take action to ensure progress with respect to reduction in the federal debt-to-Gross Domestic Product ratio.

FISCAL IMBALANCE AND TRANSFER PAYMENTS

A.        WHAT WE HEARD

A number of witnesses told the Committee that a vertical fiscal imbalance exists between the federal and provincial/territorial governments, with the result that most provinces/territories have too few fiscal resources to meet their constitutional responsibilities, such as health care and education.

Caisses Desjardins Group recommended that the federal government limit its spending to its jurisdictional areas of responsibility while determining ways in which fiscal room can be transferred to the provinces/territories. Witnesses essentially presented two approaches to the Committee: federal tax-point transfers to the provinces/territories and/or increased federal cash transfers to the provinces/territories.

The Quebec Federation of University Students indicated that a balanced approach to the fiscal imbalance should include some form of federal tax-point transfer as well as an increase in federal cash transfers. Professor Luc Godbout of the Université de Sherbrooke indicated that a potential solution to the vertical fiscal imbalance would be to transfer the tax points of the federal Goods and Services Tax (GST) to the provinces while eliminating federal transfers for social programs and negotiating other concessions.

A number of witnesses emphasized the need for enhanced federal transfers to the provinces. The Canadian Alliance of Student Associations, the Canadian Consortium for Research, the Canadian Federation for the Humanities and the Social Sciences, the College Student Alliance, the National Council for Graduate Studies and the Ontario Undergraduate Student Alliance, among others, argued for increased levels of transfers for post-secondary education through a dedicated fund; other witnesses advocated increased federal transfers to the provinces to meet other social objectives.

The Association of Manitoba Municipalities, the City of Calgary, the City of Saskatoon and the Federation of Canadian Municipalities argued that municipalities also lack sufficient funds to pay for the services that residents expect of them. The Committee was told that municipal infrastructure is under-funded, which is undermining Canada’s competitiveness and long-term economic prospects. The federal government was urged to develop a long-term plan to eliminate the municipal infrastructure deficit. The realignment of roles and responsibilities among the orders of government, the requirement for integrated approaches to rural and northern development, and the need for sufficient funding for transit systems were also mentioned.

Witnesses also discussed the issue of horizontal fiscal imbalance, since the provinces/territories have differing fiscal capacities. The Canadian Union of Public Employees and Professor Godbout proposed reform of the Equalization formula to a 10-province standard and the inclusion of resource revenues in the formula; the New Brunswick Business Council also supported the inclusion of resource revenues. The Committee was told that these changes to the Equalization formula would increase the total level of Equalization payments and, according to some witnesses, would reduce regional and social inequalities as well as enhance Canada’s competitiveness.

 The St. John’s Board of Trade, however, argued that non-renewable resource revenues should not be included in the Equalization formula because such resources are depleted over time; consequently, provinces must maximize the benefits associated with these resources while they are able to do so.

Witnesses informed the Committee that because Equalization payments are reduced as a province’s fiscal capacity increases, the Equalization program may discourage Equalization-receiving provinces from enhancing their fiscal capacity through reform or other means. The Canadian Chamber of Commerce advocated reform of the Equalization program to minimize these drawbacks by, for example, using a cash-flow standard where financial inflows minus outflows would be subject to Equalization.

The Ontario Chamber of Commerce advocated a principles-based approach which would, among other things, state that provinces which receive Equalization payments should not have a higher fiscal capacity than non-recipient provinces; nor should they have higher per-capita program expenditures than the average of contributing provinces. It was also suggested that the Equalization payment growth rate not be higher than the average real economic growth rate and that the Equalization program be reviewed periodically by the Auditor General of Canada.

B.        WHAT WE BELIEVE

The Committee believes that the Canadian federation is, at least to some extent, unbalanced and requires rebalancing. While measures designed to address both the vertical and horizontal fiscal imbalances exist, it remains the case that the federal government is collecting more in tax revenues than it requires to fulfill its constitutional obligations, the provinces/territories have too few resources to meet their responsibilities, and municipalities have insufficient resources to finance the services that the public expects from them.

The question of the existence and extent of the fiscal imbalance, as well as requests for change to the federation’s fiscal arrangements, are not new. The Committee believes that residents want, and deserve, high-quality public services for the taxes that they pay, and that they do not want to pay excessively high taxes in order to receive those public goods. Moreover, we feel that taxpayers often consider the aggregate paid in taxes and the aggregate received in public goods. Individuals may not draw a clear link between the amount paid by them in taxes to a particular order of government and the quality, quantity or range of public goods provided to them by that order of government.

Nevertheless, the Committee believes that governments should spend in a manner consistent with their constitutional obligations, recognizing the need for joint funding by more than one order of government in certain circumstances. For this reason, and bearing in mind the 23 November 2006 comments to us by the Minister of Finance about limited federal spending power and a strengthened economic union, the Committee recommends that:

RECOMMENDATION 43

The federal government meet with the provincial/territorial governments with a view to assessing their relative fiscal capacity and the extent to which they are able to fulfill their constitutional responsibilities.